accounting profit equation

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Profit (accounting)

In accounting, profit can be considered to be the difference between the purchase price and the costs of bringing to market whatever it is that is accounted as an enterprise (whether by harvest, extraction, manufacture, or purchase) in terms of the component costs of delivered goods and/or services and any operating or other expenses.

Definition

There are several important profit measures in common use which will be explained in the following. Note that the words earnings, profit and income are used as substitutes in some of these terms (also depending on US vs. UK usage), thus inflating the number of profit measures.

Gross profitequals sales revenue lesscost of goods sold (COGS), thus removing only the part of expenses that can be traced directly to the production of the goods. Gross profit still includes general (overhead) expenses like R&D, S&M, G&A, also interest expense, taxes and extraordinary items.

Operating profit equals gross profit less all operating expenses. This is the surplus generated by operations. It is also known as earnings before interest and taxes (EBIT), operating profit before interest and taxes (OPBIT) or simply profit before interest and taxes (PBIT).

(Net)profit before tax (PBT) equals operating profit less interest expense (but before taxes). It is also known asearnings before taxes (EBT), net operating income before taxes or simply pre-tax Income.

Net profit equals profit after tax (unless some distinction about the treatment of extraordinary expenses is made). In the US the term net incomeis commonly used. Income before extraordinary expenses represents the same but before adjusting for extraordinary items.

There are several additional important profit measures, notably EBITDA and NOPAT.

To accountants, economic profit, or EP, is a single-period metric to determine the value created by a company in one period - usually a year. It is the net profit after tax less the equity charge, a risk-weighted cost of capital. This is almost identical to the economist's definition of economic profit.

There are commentators who see benefit in making adjustments to economic profit such as eliminating the effect of amortized goodwill or capitalizing expenditure on brand advertising to show its value over multiple accounting periods. The underlying concept was first introduced by Schmalenbach, but the commercial application of the concept of adjusted economic profit was by Stern Stewart & Co. which has trade-marked their adjusted economic profit as EVA or Economic Value Added.

Optimum Profitâ€”This is the "right amount" of profit a business can achieve. In business, this figure takes account of marketing strategy, market position, and other methods of increasing returns above the competitive rate.

Accounting profits should include economic profits, which are also called economic rents. For instance, a monopoly can have very high economic profits, and those profits might include a rent on some natural resource that firm owns, where that resource cannot be easily duplicated by other firms.

Profit maximization

In economics, profit maximization is the (short run) process by which a firm determines the price and output level that returns the greatest profit. There are several approaches to this problem. The total revenue&ndash;total cost method relies on the fact that profit equals revenue minus cost, and the marginal revenue&ndash;marginal cost method is based on the fact that total profit in a perfectly competitive market reaches its maximum point where marginal revenue equals marginal cost.

Basic definitions

Any costs incurred by a firm may be classed into two groups: fixed costs and variable costs. Fixed costs are incurred by the business at any level of output, including zero output. These may include equipment maintenance, rent, wages, and general upkeep. Variable costs change with the level of output, increasing as more product is generated. Materials consumed during production often have the largest impact on this category. Fixed cost and variable cost, combined, equal total cost.

Revenue is the amount of money that a company receives from its normal business activities, usually from the sale of goods and services (as opposed to monies from security sales such as equity shares or debt issuances).

Marginal cost and revenue, depending on whether the calculus approach is taken or not, are defined as either the change in cost or revenue as each additional unit is produced, or the derivative of cost or revenue with respect to quantity output. It may also be defined as the addition to total cost or revenue as output increase by a single unit. For instance, taking the first definition, if it costs a firm 400 USD to produce 5 units and 480 USD to produce 6, the marginal cost of the sixth unit is approximately 80 dollars, although this is more accurately stated as the marginal cost of the 5.5th unit due to linear interpolation. Calculus is capable of providing more accurate answers if regression equations can be provided.

Total revenue - total cost method

To obtain the profit maximising output quantity, we start by recognizing that profit is equal to total revenue (TR) minus total cost (TC). Given a table of costs and revenues at each quantity, we can either compute equations or plot the data directly on a graph. Finding the profit-maximizing output is as simple as finding the output at which profit reaches its maximum. That is represented by output Q in the diagram.

There are two graphical ways of determining that Q is optimal. First, the profit curve is at its maximum at this point (A). Secondly, at the point (B) the tangent on the total cost curve (TC) is parallel to the total revenue curve (TR), meaning that the surplus of revenue net of costs (B,C) is at its greatest. Because total revenue minus total costs is equal to profit, the line segment C,B is equal in length to the line segment A,Q.

Computing the price at which to sell the product requires knowledge of the firm's demand curve. The price at which quantity demanded equals profit-maximizing output is the optimum price to sell the product.

Marginal revenue-marginal cost method

An alternative argument says that for each unit sold, marginal profit (MÏ€) equals marginal revenue (MR) minus marginal cost (MC). Then, if marginal revenue is greater than marginal cost, marginal profit is positive, and if marginal revenue is less than marginal cost, marginal profit is negative. When marginal revenue equals marginal cost, marginal profit is zero. Since total profit increases when marginal profit is positive and total profit decreases when marginal profit is negative, it must reach a maximum where marginal profit is zero - or where marginal cost equals marginal revenue. If there are two points where this occurs, maximum profit is achieved where the producer has collected positive profit up until the intersection of MR and MC (where zero profit is collected), but would not continue to after, as opposed to vice versa, which represents a profit minimum. In calculus terms, the correct intersection of MC and MR will occur when:

\frac{dMR}{dQ} < \frac{dMC}{dQ}

The intersection of MR and MC is shown in the next diagram as point A. If the industry is perfectly competitive (as is assumed in the diagram), the firm faces a demand curve (D) that is identical to its Marginal revenue curve (MR), and this is a horizontal line at a price determined by industry supply and demand. Average total costs are represented by curve ATC. Total economic profit are represented by area P,A,B,C. The optimum quantity (Q) is the same as the optimum quantity (Q) in the first diagram.

If the firm is operating in a non-competitive market, minor changes would have to be made to the diagrams. For example, the Marginal Revenue would have a negative gradient, due to the overall market demand curve. In a non-competitive environment, more complicated profit maximization solutions involve the use of game theory.

Maximizing revenue method

In some cases a firm's demand and cost conditions are such that marginal profits are greater than zero for all levels of production. In this case the MÏ€ = 0 rule has to be modified and the firm should maximize revenue. In other words the profit maximizing quantity and price can be determined by setting marginal revenue equal to zero. Marginal revenue equals zero when the marginal revenue curve has reached its maximum value. An example would be a scheduled airline flight. The marginal costs of flying the route are negligible. The airline would maximize profits by filling all the seats. The airline would determine the \Pi_max conditions by maximizing revenues.

Changes in total costs and profit maximization

A firm maximizes profit by operating where marginal revenue equal marginal costs. A change in fixed costs has no effect on the profit maximizing output or price. The firm merely treats short term fixed costs as sunk costs and continues to operate as before. This can be confirmed graphically. Using the diagram illustrating the total cost total revenue method the firm maximizes profits at the point where the slope of the total cost line and total revenue line are equal. A change in total cost would cause the total cost curve to shift up by the amount of

Accountancy

Accountancy is the process of communicating financial information about a business entity to users such as shareholders and managers. The communication is generally in the form of financial statements that show in money terms the economic resources under the control of management; the art lies in selecting the information that is relevant to the user and is reliable. As long as money consisted of gold or silver coins or was firmly linked to an stable commodity it was the most stable and reliable measure of wealth and there was every justification for normally accounting in money terms but now that free floats have been made to prevail and freely floating fiat money is no measure or unit of wealth; Accountancy is a branch of mathematical science that is useful in discovering the causes of success and failure in business.The principles of accountancy are applied to business entities in three divisions of practical art, named accounting, bookkeeping, and auditing.

Accountancy is defined by the Oxford English Dictionary (OED) as "the profession or duties of an accountant".

Accounting is defined by the American Institute of Certified Public Accountants (AICPA) as "the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof."

Accounting is thousands of years old; the earliest accounting records, which date back more than 7,000 years, were found in the Middle East. The people of that time relied on primitive accounting methods to record the growth of crops and herds. Accounting evolved, improving over the years and advancing as business advanced.

Early accounts served mainly to assist the memory of the businessperson and the audience for the account was the proprietor or record keeper alone. Cruder forms of accounting were inadequate for the problems created by a business entity involving multiple investors, so double-entry bookkeeping first emerged in northern Italy in the 14th century, where trading ventures began to require more capital than a single individual was able to invest. The development of joint stock companies created wider audiences for accounts, as investors without firsthand knowledge of their operations relied on accounts to provide the requisite information. This development resulted in a split of accounting systems for internal (i.e. management accounting) and external (i.e. financial accounting) purposes, and subsequently also in accounting and disclosure regulations and a growing need for independent attestation of external accounts by auditors.

Today, accounting is called "the language of business" because it is the vehicle for reporting financial information about a business entity to many different groups of people. Accounting that concentrates on reporting to people inside the business entity is called management accounting and is used to provide information to employees, managers, owner-managers and auditors. Management accounting is concerned primarily with providing a basis for making management or operating decisions. Accounting that provides information to people outside the business entity is called financial accounting and provides information to present and potential shareholders, creditors such as banks or vendors, financial analysts, economists, and government agencies. Because these users have different needs, the presentation of financial accounts is very structured and subject to many more rules than management accounting. The body of rules that governs financial accounting is called Generally Accepted Accounting Principles, or GAAP.

Theory

The basic accounting equation is assets=liabilities+stockholders equity. This is the balance sheet. The foundation for the balance sheet begins with the income statement, which is revenues-expenses=net income or net loss. This is followed by the retained earnings statement, which is beginning retained earnings+net income-dividends=ending retained earnings or beginning retained earnings-net loss-dividends=ending retained earnings.

Etymology

The word "Accountant" is derived from the French word , which took its origin from the Latin word . The word was formerly written in English as "Accomptant", but in process of time the word, which was always pronounced by dropping the "p", became gradually changed both in pronunciation and in orthography to its present form.

History

Proof of Beginning of Accounting in Vedas

Vedas are the oldest books of the world and after deep study of these sanskrit books, you can find that accounting was started at India's vedic period. Vikraya is found in the Atharvaveda and the Nirukta denoting â€˜saleâ€™. Sulka in the Rig veda clearly means â€˜

Bold text'[Italic text] ==How it works== For example: A student buys acomputer for $945. This student borrowed $500 from his best friend and spent another $445 earned from his part-time job. Now his assets are worth $945, liabilities are $500, and equity $445.

These are some simple examples, but even the most complicated transactions can be recorded in a similar way. This equation is behind debits, credits, and journal entries.

This equation is part of the transaction analysis model, for which we also write

Owners equity = Contributed Capital + Retained Earnings

Retained Earnings = Net Income âˆ’ Dividends

and

Net Income = Income âˆ’ Expenses

The equation resulting from making these substitutions in the accounting equation may be referred to as the expanded accounting equation, because it yields the breakdown of the equity component of the equation.

Balance sheet

An elaborate form of this equation is presented in a balance sheet which lists all assets, liabilities, and equity, as well as totals to ensure that it balances.

History

Luca Pacioli is notable for including the first published description of the method of keeping accounts that Venetianmerchants used during the Italian Renaissance, known as the double-entry accounting system. However, recently some historians and experts feel that this was already being used by the Arabs and Muslim traders with whom the Venetians would have had contact. They argue that even though Luca Pacioli formally introduced it to Europe, the credit should still go to Eastern merchants who had been using it years before. This claim is yet to be accepted by the academic community as it forces a rethink of several other aspects in this field.

From Encyclopedia

accounting

accounting classification, analysis, and interpretation of the financial, or bookkeeping , records of an enterprise. The professional who supplies such services is known as an accountant. Auditing is an important branch of accounting. The Role of the Accountant The accountant evaluates records drawn up by the bookkeeper and shows the results of this investigation as losses and gains, leakages, economies, or changes in value, so as to reveal the progress or failures of the business and also its future limitations and possibilities. Accountants must also be able to draw up a set of financial records and prescribe the system of accounts that will most easily give the desired information; they must be capable of arriving at a comprehensive view of the economic and the legal aspects of a business, envisaging the effect of every sort of transaction on the profit-and-loss statement; and they must recognize and classify all other factors that enter into the determination of the true condition of the business (e.g., statistics or memoranda relating to production; properties and financial records representing investments, expenditures, receipts, fiscal changes, and present standing). Cost accounting shows the actual cost, over a certain period of time, of particular services rendered or of articles produced; by this system unprofitable ventures, services, departments, and methods may be discovered. Development of Modern Accounting Although there were stewards, auditors, and bookkeepers in ancient times, the professional accountant is a 19th-century development. Unlike those precursors, modern accountants usually do not service a single client or employer; instead they offer their expertise, for a fee, to several individuals and businesses. The profession was first recognized in Great Britain in 1854, when the Society of Accountants in Edinburgh was given a royal charter. Similar societies were later established in Glasgow, Aberdeen, and London. In the United States the first such professional society was the American Association of Public Accountants, chartered by the state of New York in 1887. All the states and Puerto Rico and the District of Columbia now have laws under which an accountant who fulfills certain educational and experience requirements and passes an examination may be granted the title Certified Public Accountant (CPA). CPAs have organized into state and national societies. The bodies representing the accounting profession in the United States are the American Institute of Certified Public Accountants, which is the contemporary successor organization of the American Association of Public Accountants, and the American Accounting Association, organized in 1916. In the United States, the Financial Accounting Standards Board, an independent nongovernmental organizaiton sponsored by financial-reporting industry groups, is the main institution responsible for establishing accounting standards and rules. The International Accounting Standards Board develops standards and rules that are accepted by many nations. With the growth of corporate activity in the 20th cent., the field of accounting has increased greatly in importance and has seen many improvements in theory and techniques. The chief causes of changes in accounting methods have been more complex tax laws and regulations and the need to keep uniform accounts for possible governmental or public scrutiny. Contemporary accounting firms also have taken on managerial functions and are no longer concerned simply with ascertaining and reporting financial condition but also with advising a client how to act on this information; they also consult on information-technology systems and other services. This has greatly increased the potential for conflicts of interest, because the services provided to clients by accounting firms must be evaluated in their audits and because the fees paid by a client for such services may be more important to the accounting firm than that paid for an audit, potentially undermining the independence of the audit. As a result, in 2000 the Securities and Exchange Commission specified the types of services accounting firms could provide without compromising their independence as auditors. A series of revelations concerning accounting firms' failure to detect or publicly challenge irregularities or fraud when auditing the finances of a number of corporations led Congress to establish (2002) the Public Company Accounting Oversight Board. The board is appointed by the Securities and Exchange Commission and has the power to register and regulate accountants and firms that act as auditors. It sets standards for audits and is responsible for reviewing audits and disciplining accountants and accounting firms. Bibliography See N. A. H. Stacey, English Accountancy, 1800-1954 (1954); M. Backer, ed., Modern Accounting Theory (1966); L. Goldberg and V. R. Hill, The Elements of Accounting (3d ed. 1966); J. D. Edwards, History of Public Accounting in the United States (1960); A. J. Briloff, Unaccountable Accounting (1972); M. Chatfield, A History of Accounting Thought (1977).

From Yahoo Answers

Question:Jonalyn operates the Magic Touch cleaning service specializing in commercial office buildings. Last year, her company made 25,000 office visits at $80 per visit. Her variable costs were $40 per visit and fixed costs totaled $400,000. Jonalyn is working on next year s budget and estimates her variable costs will increase $5 per unit and fixed costs will rise by $100,000. Jonalyn desires to maintain his current per visit price. How many visits will her company have to make to earn the same profit as last year? (round up all fractions)
a. 25,000
b. 28,572
c. 31,429
d. 35,231
e. None of the above are correct.
I have no idea how to do this. Please help. Thank you.

Question:Tanya imports sweaters from Peru and sells them from her home. She collects $400,000 in revenue a year, and spends $200,000 on the sweaters and shipping costs, as well as $25,000 on accounting services and utilities. She used to make $100,000 per year working for an advertising agency. Now she works out of the basement of her house, for which she doesn't have any other marketable use. She has no other expenses.
Tanya's economic profit is:
A. -$25,000
B. $100,000
C. $75,000
D. $175,000
I know that accounting profit is $175,000 and the equation for economic profit is economic profit = accounting profit - opportunity cost.
I'm just unsure which counts as opportunity cost bc my answer is not one of the choices ><
THANKS! SORRY!!
The TITLE of the question is wrong...i meant ECONOMIC PROFIT!

Answers:Tanya would get 100'000 in ad agency as opportunity profit.
But she gets 175'000 instead. So just calculate difference 175'000-100'000=75'000
Correct answer is "C" Economic profit is 75'000.